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Investors' Soapbox PM

Mortgages Aren't Moribund

Updated May 1, 2007 11:59 pm ET / Original Sept. 15, 2019 5:39 am ET

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Credit Suisse

WE ARE RAISING OUR 2007 mortgage-industry origination forecast to $2.5 trillion, up from $2.15 trillion. Our 2007 forecast is 11% below 2006's upwardly revised total of $2.8 trillion (the prior figure was $2.5 trillion as compiled by the Mortgage Bankers Association).

Purchase volume should amount to $1.30 trillion, down 10% from 2006 and amount to the fourth-highest total on record. Purchase activity will be negatively impacted by more stringent underwriting guidelines and lower housing activity in 2007.

Substantially all of our revision relates to higher refinance activity.

We now expect refinances to comprise 48% of originations in 2007 or $1.2 trillion, up from our original forecast of $865 billion. This represents a decline of 11% from 2006. Refinance activity has proved more resilient in early 2007, owing to elevated relatively low long-term mortgage rates and the impending wave of adjustable-rate mortgage resets.

U.S. residential mortgages outstanding were roughly $10.4 trillion at the end of 2006, according to the Federal Reserve, up 8.8% from 2005. We expect $500 billion in mortgage originations for the first quarter (approximately 55% from purchases), down 12% from the $577 billion in originations in the fourth quarter of 2006.

Leading indicators for home-sales activity, such as housing-starts data remained suppressed, and we believe the housing market has yet to find a bottom. Starts rose 1% (from February) to an annualized rate of 1.518 million units, but were down an outsized 23% from the year-ago month. Permits increased 1% sequentially, but fell 26% year over year to 1.544 million units (near their lowest level in 10 years). We expect these metrics to hover around these levels, owing to bloated inventory levels and a slowdown in housing turnover.

Existing-home sales decreased 8% sequentially and were down 11% year over year to 6.12 million units in March. New-home sales rose modestly to 858,000 units, up 3% from February, but down an outsized 23% from the year-ago month. New median home prices increased 6% year over year, while median existing-home prices declined nominally year over year.

In 2007, we expect sales to decline by roughly 6%, owing to waning investor demand, record inventory levels, and slowing home-price appreciation.

New-home inventory rose slightly to 545,000 units in March and at the current sales pace represents a 7.8-month supply of homes. Housing inventory for existing homes declined in March to a total of 3.745 million homes, which at the current sales pace represents a 7.3-month supply. When inventory levels exceed six months of supply, it has historically been more favorable to buyers versus sellers.

Absolute inventories are at record high levels, which should damp price appreciation well into 2007, as housing activity and turnover slows. Should turnover slow more than expected, the level of unsold homes would rise faster than anticipated and would likely lead to more severe home-price depreciation. We expect inventory levels will remain elevated until housing affordability improves, which should result from stagnant home-price appreciation (or outright depreciation), rising income levels and stable/falling mortgage rates.

Average new-home prices were up 10.7% year over year, while average existing-home prices declined 0.4%. Home-price appreciation is unlikely to accelerate meaningfully in the intermediate term until housing supply and demand moves back into balance.

We expect home-price appreciation will be marginally negative for existing homes, while new home prices should be more resilient at 2% in 2007. New-home prices should remain under pressure as builders make sizable-price concessions to whittle down inventory levels. We do not expect a reacceleration in home-price gains until affordability improves and inventory levels are reduced.

We rate
Countrywide Financial
Outperform and our 12-month price target of $50 represents an absolute P/E of roughly 10 times our 2008 earnings-per-share estimate of $5.00. We rate both
Fannie Mae
and
Freddie Mac
at Neutral. Our 12-month price targets are $63 and $71 for Fannie and Freddie.

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